Hedge funds have all sorts of worrisome handicaps. Such as: Obscenely high expenses. Frequently, a lock-up period during which you cannot sell shares. (Typically a year, but sometimes as long as 10 years.) Little or no transparency. (I.e., often you’re just buying a pig in a poke.) Often, a dismal track record. Often, a manager who would almost make the late, unlamented Charles Steadman look … adequate.
What’s the case for hedge funds?
*They have a low correlation with the stock market (they march to different drummers), and
* In 2000, when the Standard & Poor’s 500 dropped 9.1 points, an index of hedge funds rose 4.85%. In 2001, the numbers were minus 11.9 percent and plus 4.42%. In 2003, the numbers were minus 22.1% and plus 3.04%. John Longo, who is writing a book about hedge funds, spoke recently in Ridgewood before the Investors Club of the Ridgewood Hobbyists – and conceded that the average investor doesn’t need a hedge fund. But well-to-do people, he argued, might benefit.
What defines hedge funds? Originally, Longo said, the differences were that (1) they could sell short—bet against stocks or the stock market, (2) they could use leverage (borrowing money), and (3) they were been largely exempt from SEC regulation. Said Longo, “You don’t even need a driver’s license to start a hedge fund. All you need to do is raise enough money.”
These days, he noted, many hedge funds just focus on total returns—and don’t sell short or use leverage.
Longo is clinical associate professor of finance at Rutgers University in New Jersey. He is also senior vice president of strategy and chairman of the seven-member investment committee for the MDE Group, a New Jersey-based money management firm with $1.7 billion under management. Through MDS he is also a principal in a $100 million hedge fund. He was formerly a vice president for Merrill Lynch.
His predictions regarding the future of hedge funds:
Their charges – typically, a 2% fee and 20% of the profits – will come down. (“But the best funds can still charge anything,” he added. One fund actually charges 50% of all profits.)
They will become not just transparent, but more liquid – the lock-up periods will shrink.
They will invest more in niche markets, like Vietnam, or employ more unusual strategies, like cross-market arbitrage.
Why? Increased competition. A more difficult investment environment. More high-profile failures. Greater participation by institutions, like university funds. Increased regulatory scrutiny.
In looking for hedge funds to invest in, Longo said, MDE tries to lower the fees its clients are charged. He believes that little-recognized managers have the best chance of earning superior returns, but his firm also invests with some larger funds. Other criteria he uses: low downside risk, a good five-year record, a lack of exotic securities, experienced managers, timely client service, and so forth.
Some other points he made about hedge funds:
*To invest, you need $1 million and a yearly income of $250,000 for two years.
• Compared to the mutual-fund universe, hedge funds are quite small, with respect to assets under management.
• Pension funds on average invest less than 10% in hedge funds, so they have room to grow.
* One reason funds blow up is that they use too much leverage. The leverage of Long-Term Capital Management, which almost went belly-up in 1998, was 30 to 1. Recently two of the hedge funds of Bear, Stearns had leverage, at their peak, greater than 10 to 1.
* There are around 14,000 hedge funds now, and the number keeps growing. (Many of them close down, then start a brand-new new fund, Longo reported. One reason: The managers of a fund that loses money cannot walk off with a percentage of the profits until the old shareholders are made whole. But with a new fund, the managers can start from scratch. (“It’s probably not right,” said Longo, “but it happens all the time.”)
* Recently the highest-paid hedge-fund managers were T. Boone Pickens of BP Capital Management, Stephen Cohen of SAC Capital, James Simons of Renaissance Technology, Paul Tudor Jones of Tudor Investors, and Stephen Feinberg of Cerberus.
* The stock market isn’t cheap now, but it’s reasonably priced for the period ahead. Longo expects total returns of 8.25% a year in the years to come.
* Stocks that look good now have a big exposure to overseas markets. Two he mentioned: Coca-Cola and General Electric. As for housing, he still isn’t buying. “There’s always another shoe dropping.” Longo writes a personal finance column for Mensa, the high IQ society. My own impression of him was: He himself must have an IQ between 180 and 200.
What’s the case for hedge funds?
*They have a low correlation with the stock market (they march to different drummers), and
* In 2000, when the Standard & Poor’s 500 dropped 9.1 points, an index of hedge funds rose 4.85%. In 2001, the numbers were minus 11.9 percent and plus 4.42%. In 2003, the numbers were minus 22.1% and plus 3.04%. John Longo, who is writing a book about hedge funds, spoke recently in Ridgewood before the Investors Club of the Ridgewood Hobbyists – and conceded that the average investor doesn’t need a hedge fund. But well-to-do people, he argued, might benefit.
What defines hedge funds? Originally, Longo said, the differences were that (1) they could sell short—bet against stocks or the stock market, (2) they could use leverage (borrowing money), and (3) they were been largely exempt from SEC regulation. Said Longo, “You don’t even need a driver’s license to start a hedge fund. All you need to do is raise enough money.”
These days, he noted, many hedge funds just focus on total returns—and don’t sell short or use leverage.
Longo is clinical associate professor of finance at Rutgers University in New Jersey. He is also senior vice president of strategy and chairman of the seven-member investment committee for the MDE Group, a New Jersey-based money management firm with $1.7 billion under management. Through MDS he is also a principal in a $100 million hedge fund. He was formerly a vice president for Merrill Lynch.
His predictions regarding the future of hedge funds:
Their charges – typically, a 2% fee and 20% of the profits – will come down. (“But the best funds can still charge anything,” he added. One fund actually charges 50% of all profits.)
They will become not just transparent, but more liquid – the lock-up periods will shrink.
They will invest more in niche markets, like Vietnam, or employ more unusual strategies, like cross-market arbitrage.
Why? Increased competition. A more difficult investment environment. More high-profile failures. Greater participation by institutions, like university funds. Increased regulatory scrutiny.
In looking for hedge funds to invest in, Longo said, MDE tries to lower the fees its clients are charged. He believes that little-recognized managers have the best chance of earning superior returns, but his firm also invests with some larger funds. Other criteria he uses: low downside risk, a good five-year record, a lack of exotic securities, experienced managers, timely client service, and so forth.
Some other points he made about hedge funds:
*To invest, you need $1 million and a yearly income of $250,000 for two years.
• Compared to the mutual-fund universe, hedge funds are quite small, with respect to assets under management.
• Pension funds on average invest less than 10% in hedge funds, so they have room to grow.
* One reason funds blow up is that they use too much leverage. The leverage of Long-Term Capital Management, which almost went belly-up in 1998, was 30 to 1. Recently two of the hedge funds of Bear, Stearns had leverage, at their peak, greater than 10 to 1.
* There are around 14,000 hedge funds now, and the number keeps growing. (Many of them close down, then start a brand-new new fund, Longo reported. One reason: The managers of a fund that loses money cannot walk off with a percentage of the profits until the old shareholders are made whole. But with a new fund, the managers can start from scratch. (“It’s probably not right,” said Longo, “but it happens all the time.”)
* Recently the highest-paid hedge-fund managers were T. Boone Pickens of BP Capital Management, Stephen Cohen of SAC Capital, James Simons of Renaissance Technology, Paul Tudor Jones of Tudor Investors, and Stephen Feinberg of Cerberus.
* The stock market isn’t cheap now, but it’s reasonably priced for the period ahead. Longo expects total returns of 8.25% a year in the years to come.
* Stocks that look good now have a big exposure to overseas markets. Two he mentioned: Coca-Cola and General Electric. As for housing, he still isn’t buying. “There’s always another shoe dropping.” Longo writes a personal finance column for Mensa, the high IQ society. My own impression of him was: He himself must have an IQ between 180 and 200.
